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Though Mary Jo White, chairman of the Securities and Exchange Commission, called the idea “creative,” questions must be answered before such a proposal is put formally before all the commissioners. A key concern: What evidence exists that current SEC audits of registered investment advisers are missing significant amounts of fraud against investors?

Mr. Gallagher has posited that because the SEC audits only 9% of advisers under its authority, a large amount of malfeasance is going undetected. But he offers no proof. One would expect that if SEC audits had uncovered many cases of investors' being harmed by what the agency calls “deficiencies,” Mr. Gallagher would support his case by citing those figures.

The amount of fraud discovered in a random sample of 9% should indicate the level of fraud in a universe fairly accurately. After all, pollsters can get a good read on the likely outcome of elections from much smaller samples.

SIGNIFICANT DEFICIENCIES

According to the SEC's annual report, 80% of exams by the SEC or self-regulatory organizations identify deficiencies; 35% find “significant deficiencies,” which might damage investors. But only 13% of those are referred to enforcement for action. Unfortunately, the report does not differentiate percentages of significant deficiencies found at investment advisers versus broker-dealers.

Assuming evidence of serious deficiencies at many investment advisers, and accepting that hiring outside examination experts is required, the next question is how much that would cost each advisory business. A related question concerns audit frequency. Would they be required of every firm every year, two years, three years? Only 46% of brokers are audited annually.

ACCEPTABLE EXPENSE

According to one compliance expert, a routine audit can be done for less than $10,000 and would cost about $5,000 at most firms. That figure would be widely acceptable, even for small firms. Some firms might find $20,000 acceptable if it wasn't an annual expense. But uncertainty about those estimates should worry advisers.

The price tag could be much higher, judging by the cost of a business' custody audit. According to Jonathan Roberts, senior vice president of Klingenstein Fields & Co., the bill for a custody audit is about $20,000. That would hit small firms hard if an operations audit carried similar expense.

Another consideration: Are there less expensive ways to achieve better oversight of investment advisers?

Some have suggested they would be willing to pay an annual fee to help finance hiring additional SEC staff to conduct expanded examinations. Why hasn't the agency embraced that idea, which seems to be the simplest solution?

Mr. Gallagher still likes the idea of Finra's conducting the audits as a backup to the SEC. Investment advisers staunchly oppose that, arguing that Finra does not have the knowledge of the investment advisory field.

Could changes to Finra's operations or attitude make this proposal palatable to investment advisers? How much would it cost to bring the regulator up to speed on investment advisory operations and issues? Who would cover those costs? What fee would Finra charge advisers for doing the audits?

Many advisers have argued for a separate SRO for registered investment advisers, but the SEC has not moved in that direction, and such an approach likely would imply higher costs for advisers.

Because there are so many open questions about the best way to confirm that investment advisers are in compliance with securities laws, the SEC should not rush to Mr. Gallagher's position. Instead, it should take the time to determine how often investment advisory firms need to be examined to ensure that investors are being treated fairly.

The SEC must assess all proposals and select the one that is most cost effective, remembering that the investing public ultimately will bear the price — directly by paying higher fees, or indirectly by receiving fewer services.